Report on the paper
and Remaining Challenges:
The Emergence of a Gradualist Success
by Kemal Dervis and Timothy Condon
Kermal Dervis and Timothy Condon describe the benefits of the gradualist approach to the transformation of Eastern European economies in their article Hungary's Partial Successes and Remaining Challenges: The Emergence of a Gradualist Success They point to the strength of this strategy in its ability to minimize the negative social consequences of transformation, while accelerating change and accomplishing systematic transformation and integration with the Western Capitalist economies. Dervis and Condon explain that the Hungarian approach has, from the beginning been, pragmatic, ready to adjust policies rapidly to the lessons of experience and unwilling to embark on sudden and large-scale social engineering. It is in this way, they believe, that the Gradualist approach has been so successful in avoiding crises and catastrophes. The authors view this strategy not as being the result of a deliberate plan by Hungarian officials, but rather as a consequence of the need to balance the desires of the old Communists to reform the Communist system and maintain their control against the more radical capitalists and market reformers trying to accelerate change and remove the old vestiges of the former regime entirely. The main theory at work in their evaluation of Hungarian reform is the idea that a systematic transformation will bring about an eventual acceleration of growth resulting from an improved over all total factors production performance.
The systematic transformation of the Hungarian economy was begun as early as 1985 with the first real experiments with large scale market socialism. In this way, Hungary was able to get a jump on reforms and has more experience in the reform process. Hungarian reformers have followed a specific sequence of reform during this period. Hungary first concentrated on reorganizing and getting a hold on its debt problems and current account balance of payments problems. After having accomplished this, it could then make way for strengthened exports and a reorientation of its principle export market--the West. In order to accomplish this step, it liberalized foreign trading rights. After having alleviated itself of its balance of payments problems, Hungary was open to attract a great deal of direct foreign investment as well as a strengthened position in international capital markets. This same sequence of systematic, gradual transformation has lead to a more secure international reserve holding and a solid access to international capital markets.
As stated before, Hungary's approach was in no way dogmatic or inflexible. The policy towards privatization clearly indicates the willingness on the part of Hungarian reformers to adjust and re-adjust their approaches to the current situations and problems. In 1989, Hungary began a full fledged attempt to re-build the private economy. They experimented with partial ownership, but soon found that this was not the most successful way to manage privatization. They discovered problems like unequal distributional effects, imperfect information problems, corruption problems and several other problems resulted from this first method. Instead of sticking with this strategy, they shifted their thinking and re-adjusted it to become a more centralized and wide scale privatization scheme.
They do acknowledge many of the problems that have plagued Hungarian reform as well as those problems that have plagued reforms all across Eastern Europe. They point to the relative success of Hungary as proof that the gradualist approach is the best. They blame the decline in GDP on a loss from export revenues due to the break up of the CMEA. Many of the problems they describe as being inevitable and partially a result of the economic slow down in the West that occurred at the same time. They stress that changes of this magnitude take a great deal of time and can not be forced to occur over night, while addressing complaints of too slow a movement towards a complete market economy.
The authors argue that Hungary is developing into a gradualist success story, because it was able to overcome its debt crisis and the collapse of the CMEA without suffering a major macro economic instability. The poor results in GDP associated with this transformation are relatively moderate when compared to Hungary's neighbors Dervis and Condon explain.
Is this really true that Hungary has been able to achieve partial economic transformation without a great deal of hardship and sacrifice? A list of macro economic indicators would seem to indicate so. Per capita GDP in 1991 was 3,330 USD--higher than any other country in Eastern Europe. The CSFR had a per capita income of 2,100 USD and Poland had one of 1,800 USD. The percentage of GDP growth in 1991, while negative was the best of every country in Eastern Europe except that of Poland, at -10%. Inflation for 1991 was by far the best of any country in Eastern Europe at 35%. It was half of Polish inflation (76%), and was nearly 12 and one half times less than that of Bulgaria which suffered from 430% inflation. The unemployment rate of 8% for 1991 was equal to western levels and was less than that of Poland and Bulgaria, and equal to that of Czechoslovakia.
It is encouraging to see such success in Hungary. I think however, that it is important not to loose sight of the successes of the countries that have engaged in a more radical approach. The figures above are from 1991, a year when there was a great deal of change and re-adjustment in both Poland and Czechoslovakia. If there is anything that strikes me as interesting in these figures it is that the numbers for the countries who have chosen more rapid and extensive reforms have better figures than one might expect. In addition, they are not disastrously bad, and therefor do not, in my opinion, warrant being labeled as failures or as dangerous reforms. Hungary will certainly have a sustained period of unemployment and inflation because of the gradual restructuring of the economy and the constant nature of the deliberate change.
The shock therapy countries have chosen to take all of their medicine in one grand gulp--something which is reflected in the figures above. The simple fact of the matter is that the amount of required change is the same in all the Eastern European nations. They all need to adjust their economies to the same levels, which will required the same quantity of changes. These changes will result in an initial negative shock. However after this period, growth in the economy will more than make up for this negative shock and these countries will be far ahead of where they were during this short period of decline. The radical shock countries will have put themselves thorough this process in less time, and thus will be able to start growing faster sooner in my opinion. It may appear that Hungary is a leader at the moment, but I wonder how much longer it will be able to maintain this position in the face of large scale growth from the other Eastern European countries which is just around the corner, and in many respects already here.
Hungary may be building itself a future of stagnation, not growth through its pursuit of this gradualist policy. Secondly, the central direction of this reform is slow and inefficient. The need for transformation and reform is a direct result of inefficient planning and management at the central level. How can one expect an inherently inefficient system to transform itself into an efficient one when many of the original inherent problems are still present? Is the free market not the best place to make decisions and precede down a path of transformation rather than restructuring using central planning in the absence of crucial market signals? Lastly, this type of controlled and methodical transformation discourages and in some cases even outright prohibits the spontaneous establishment of private capitalist enterprises and phenomenon that are so crucial to free market economies.
This spontaneous appearance and growth of business ventures, organizations, enterprises, and services are an important feature of a naturally functioning Capitalist economy. It can not function efficiently without it. In the presence of such unplanned and undirected freely forming structures--mutual funds or other types of investment funds for example--an economy will grow even faster than it would without such structures. By discouraging this sort of growth with the pursuit of gradual and institutional reform, Hungary may simply breed a newer version of its former self. It could very well be choking off the very sort of more freely forming reforms it so desperately could find itself in need of one day.
Kermal Dervis and Timothy Condon: Hungary's Partial Successes and Remaining Challenges: The Emergence of a Gradualist Success, in Blanchard, Oliver; Foot, Kenneth; and Sachs, Jeffery. eds. The Transition in Eastern Europe, Volume 1, Country Studies. University of Chicago Press: Chicago, 1994.